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ECONOMIC OUTLOOK

J ust over a year after the unprecedented economic losses induced by the

COVID-19 Pandemic in March and April 2020, the nation and California have both

started on the path to recovery. However, there still is a long way to go to reach

pre-pandemic levels. Since the height of the COVID-19 Recession in April 2020, and a

full year into the recovery through April 2021, the nation has added back 14.1 million

jobs—63.3 percent of the 22.4 million jobs lost in March and April 2020. Similarly, as of

March 2021, California has added back 1.2 million jobs—43.7 percent of the 2.7 million

jobs lost in March and April 2020. Despite these strides, U.S. and California nonfarm

employment were still around 6 percent and 9 percent lower than pre-pandemic levels,

respectively, in March 2021, roughly equal to the respective peak-to-trough drop during

the Great Recession.

With low COVID-19 positivity rates, one-third of Americans and Californians fully

vaccinated as of early May, and additional federal and state actions taken to support

the recovery in the six months since the Governor’s Budget forecast was finalized, the

nation and the state are expected to recover to pre-pandemic levels of nonfarm

employment by the end of 2022 and by mid-2023, respectively. This is significantly faster

than the more than six years it took to recover during the Great Recession. Recovery of

low-wage sectors, however, is expected to lag as these sectors bore the brunt of the

recession, accounting for nearly three out of four jobs lost in March and April 2020. While

the overall outlook has been significantly upgraded since the Governor’s Budget was

published in January 2021, downside risks to the forecast remain, including potentially

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worsening public health conditions due to COVID-19 variants and vaccine hesitancy

and the possibility of a stock market correction.

REGAINING GROUND AFTER AN UNPRECEDENTED CONTRACTION

The pandemic caused a one-of-a-kind recession with both demand and supply side

impacts and a sudden drop in economic activity in March and April 2020. U.S. real GDP

contracted by 31.4 percent in the second quarter of 2020—the largest recorded drop in

history on a seasonally-adjusted annualized rate basis (SAAR)—and both the U.S. and

California lost a record number of nonfarm payroll jobs. The federal government

responded with various measures to mitigate the impacts of the pandemic,

including the $2.2 trillion CARES Act in March 2020, followed by the $900 billion

Consolidated Appropriations Act in December 2020, and the $1.9 trillion American

Rescue Plan Act in March 2021. Extensions to unemployment insurance benefits and

emergency unemployment insurance programs were enacted, including the first ever

Pandemic Unemployment Assistance program (PUA) for individuals who do not qualify

for traditional unemployment insurance benefits, including self-employed and

independent contractors. The PUA program and extended benefits are scheduled to

expire in early September 2021. State and federal eviction and foreclosure

moratoria are instated through the end of June 2021 to protect renters and property

owners who have been unable to stay current on their payments due to

pandemic-related hardships. Finally, California also took several actions to

support impacted Californians, including the $7.6 billion Golden State Stimulus

package which incorporated more than $2 billion for the California Small Business

COVID-19 Relief Grant Program.

These actions helped support recovery from the historically deep economic

contraction. After the record 31.4 percent-drop in the second quarter of 2020, U.S. real

GDP rebounded by a record 33.4 percent SAAR in the third quarter and continued to

grow in the subsequent two quarters, albeit at slower rates. As of the first quarter of

2021, U.S. real GDP recovered to just above the 2019 second quarter level but

remained lower than the pre-recession peak in fourth quarter of 2019.

As is often the case during economic contractions, government expenditures

increased and were up one percent over the fourth quarter of 2019 level by the first

quarter of 2021. Exports decreased and remained 11.2 percent below pre-recession

levels in the first quarter of 2021 as countries across the globe were impacted

by the recession and international trade was restricted. Exports have been declining

since various tariffs were introduced in 2018, a trend that was exacerbated by

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202 MAY REVISION — 2021-22

the recession. As of the first quarter of 2021, exports were at around 2013 levels. Private

investment was 2.4 percent higher than its pre-recession level in the first quarter of 2021.

The recovery story for GDP revolves around personal consumption expenditures, which

account for over two-thirds of GDP. In particular, consumption of goods surpassed

pre-recession levels in the third quarter of 2020, and continued to steadily grow to

12.5 percent above pre-recession peak by the first quarter of 2021. With consumption of

services remaining at 5.7 percent below the pre-recession level, overall consumption

was 0.1 percent below the fourth quarter of 2019 level in the first quarter of 2021. These

patterns illustrate the uneven impacts of the recession, with high-income households

fueling economic activity through purchases of goods such as motor vehicles and

parts, furnishings and household durable equipment, and recreational goods, while

millions of Americans who worked in low-wage sectors remained unemployed.

Two months after marking a record low unemployment rate of 3.5 percent, the U.S.

unemployment rate peaked at a historic high of 14.8 percent in April 2020. The U.S.

unemployment rate decreased to 6.1 percent in April 2021, 2.6 percentage points

higher than the pre-pandemic level in February 2020. Despite twelve months of

improvement, there were 7.6 million fewer employed individuals and around 3.5 million

fewer Americans in the labor force in April 2021 than in February 2020.

California trends broadly mirrored the nation, however, the state historically experiences

a larger economic contraction than the nation during recessions. As with the nation,

from a low of 4.3 percent in February 2020, the California unemployment rate reached

a record-high of 16 percent in April 2020 before decreasing to 8.3 percent through

March 2021. There were 1.2 million fewer employed Californians and more than half a

million fewer people in the labor force in March 2021 than in February 2020.

For both the state and the nation, the nonfarm employment contraction during the

recession was much larger and more sudden than during the Great Recession. The

large labor force decreases in 2020 were unique to the recession. Many were forced to

drop out of the labor market in order to care for children and relatives as schools and

childcare facilities closed. Historically, labor force participation is fairly stable

and people tend to stay in and enter the labor force even as employment decreases in

order to meet their economic needs. The U.S. lost a whopping total of 22.4 million

nonfarm jobs in March and April 2020, and as of April 2021, national nonfarm jobs were

still at around 2016 levels. Similarly, after a record two-month loss of 2.7 million jobs in

March and April 2020, California added 1.2 million jobs through March 2021, bringing

nonfarm jobs back to August 2015 levels.



Low-wage sectors, defined as a sector that has an average wage below the overall

nonfarm average wage, accounted for nearly three-quarters of all nonfarm job losses

despite only making up a little less than half of all nonfarm jobs. Four out of the 11 major

sectors are low-wage: leisure and hospitality, other services, educational and health

services, and trade, transportation and utilities. As of March 2021, low-wage sector jobs

remained significantly lower than February 2020 levels (7.2 percent and 11.4 percent

lower for the U.S. and California, respectively) compared to their high-wage

counterparts (3.9 percent and 6 percent lower for the U.S. and California,

respectively). All major industry sectors remained below their pre-recession levels in

March 2021, with leisure and hospitality significantly lagging in recovery due to the

sector incurring a disproportionately large shock in the second quarter of 2020. (See

figure on U.S. and California Jobs by Industry.)

THE NATION

The U.S. forecast incorporates developments and improvements in public health

conditions as well as all enacted federal stimulus packages and assistance measures as

of April 2021. U.S. real GDP is projected to return to pre-pandemic levels by mid-2021,



just one-and-a half years after its pre-recession peak in the fourth quarter of 2019. This is

only slightly longer than the early 1990s and early 2000s recessions, and is much shorter

than the nearly four-year recovery of the Great Recession. (See figure on U.S. Real GDP

and Years to Recovery.)

Following an annual contraction of 3.5 percent in 2020, U.S. real GDP is projected to

grow by 6.2 percent in 2021 before slowing to 2.2 percent in 2023 and 2.3 percent in

2024. (See figure on Selected Economic Indicators.) Real GDP growth is expected to

remain largely driven by consumption (contributing nearly four-fifths of total GDP

growth on average through 2024), followed by investment (contributing over one-fifth).

Government expenditures are projected to make a small positive contribution that is

offset by a small negative contribution from net exports, as imports are projected

to grow faster than exports.

While real GDP is expected to recover by the second quarter of 2021, a return to full

employment, which generally takes longer, is projected to occur towards the end of

2022. The U.S. unemployment rate is projected to decrease from an annual average of



8.1 percent in 2020 to 5.2 percent in 2021 and to continue to gradually fall to

3.5 percent by 2024. The U.S. labor force is expected to reach 2019 levels in 2022. U.S.

nonfarm jobs are expected to recover to pre-pandemic levels by the fourth quarter of

2022, led by jobs in high-wage sectors recovering in the first quarter of 2022.

Manufacturing, a high-wage sector, and two low-wage sectors, retail trade and leisure

and hospitality, are not projected to recover within the forecast window, or through the

end of 2024.



U.S. headline inflation as measured by the consumer price index (CPI) slowed to

1.2 percent in 2020, the lowest rate since 2015. With increased economic activity in 2021

and gasoline prices recovering from 2020 lows, U.S. headline inflation is projected to

rebound to an average of 2.5 percent in 2021. Inflation is then expected to slow to

1.8 percent in 2022 before gradually increasing to 2.1 percent by 2024. Core CPI, which

excludes food and energy, slowed to 1.7 percent in 2020 and is projected

to accelerate to 1.9 percent in 2021 and 2.3 percent by 2024. Interest rates have

remained near zero since March 2020 and the Federal Reserve is expected to begin

raising rates in mid-2024 when inflation surpasses the Federal Reserve’s long-run

average inflation target of 2 percent, as measured by the core personal consumption

expenditures price index (PCE). Inflation as measured by core PCE is historically slightly

slower than as measured by core CPI.

CALIFORNIA

In addition to incorporating recent public health developments and enacted federal

stimulus, the California forecast reflects additional state assistance and actions enacted

through April 2021.

California’s unemployment rate is projected to broadly follow U.S. trends of steady

decline but at a slightly higher level throughout the forecast window. California’s

unemployment rate is projected to return to pre-pandemic levels in 2024, substantially

faster than during the early 1990s recession and the Great Recession. This is due to the

unique nature of the recession and to the unprecedented federal and state assistance

allocated to support the recovery. (See figure on U.S. and California Unemployment

Rates.)



California’s labor force is projected to recover by mid-2022 and civilian employment is

expected to grow faster than nonfarm employment in 2021 and 2022 as reopening of

the economy allows for the resumption of some self-employment and independent

contractor work that saw reduced demand during the pandemic. While re-entry of

independent contractors boosts civilian employment and lowers California’s

unemployment rate, contractor work tends to yield lower wages and offers fewer

benefits.

Following an annual job loss of 1.2 million, or 7 percent, in 2020, California nonfarm

employment is projected to grow by 2.6 percent on average during the forecast

window and recover to the first quarter of 2020 pre-pandemic level in mid-2023. This

projected nonfarm employment recovery is faster than after any recession since the

early 1990s. (See figure on California Job Losses and Years to Recovery.) Mirroring the

nation, high-wage sectors generally recover faster than low-wage sectors as jobs in

high-wage sectors were more compatible with telework and less affected by

the recession. Manufacturing and retail trade are not projected to recover to their

respective pre-recession peaks during the four-year forecast window due to

expectations of continued long-term structural change, such as automation. The leisure



and hospitality sector, which lost about half of its jobs in March and April 2020, is

projected to inch back to pre-recession levels by the fourth quarter of 2024.

Robust nonfarm employment growth is projected to support growth in wages and

salaries, which account for roughly half of total personal income. Growth in California

total wages and salaries slowed from 5.9 percent in 2019 to 1.6 percent in 2020, the

lowest annual growth since the decrease of 5.2 percent in 2009 during the Great

Recession. Despite nonfarm employment decreasing by a record 7 percent in 2020,

total wages and salaries continued to grow, albeit at a significantly slower rate, as

nearly three out of every four jobs lost were in low-wage sectors. High-wage sectors

were relatively insulated from the impact of the pandemic, exacerbating inequality

that predated the economic and public health crisis.

In contrast to the decline of 3.3 percent in total personal income in 2009 during the

peak of the Great Recession, California personal income accelerated from 4.7 percent

in 2019 to 6.9 percent in 2020. This was largely driven by transfer payments which rose by

a record 44.4 percent in 2020, compared to an increase of 13.1 percent in 2008, and

increases of around 11 percent in 2009 and 2010. Moreover, nearly all other major

personal income components continued to grow in 2020, with the exception of



property income, which decreased by 1 percent due to interest income falling by

2.4 percent and dividends declining by 1.3 percent. Interest income is projected to

continue decreasing until the Federal Reserve starts to raise interest rates in 2024. The

decrease of 1.3 percent in dividends followed a decrease of 1.1 percent in 2019. The

S&P 500 Index fell by 33.9 percent from February 2020 to March 2020, compared to a

drop of over 50 percent over a period of nearly one-and-a-half years during the Great

Recession. Thereafter, the S&P 500 Index recovered within just five months, compared to

four years during the Great Recession. The S&P Index has since continued to set new

record-highs, closing the month of April at 4,181, or 23.5 percent above the February

pre-recession high. Excluding transfer payments, all other personal income components

combined grew by 0.7 percent in 2020, compared to a decrease of 5.4 percent in

2009. (See figure on Contributions to California Personal Income Growth.)

California total personal income is projected to increase by 4 percent in 2021, slowing

to 0.3 percent in 2022 as many unemployment, direct stimulus, and other assistance

programs are scheduled to end in 2021. With transfers boosting personal income growth

through the fourth quarter of 2020, and with the majority of those payments ending in

2021, per capita personal income growth is expected to substantially decelerate from

the fourth quarter of 2020 to the fourth quarter of 2021. Transfer payments are projected

to fall by 21 percent in 2022 before accelerating to 4.7 percent in 2024, with social

security benefits, Medicaid, and Medicare benefits returning to their historical share of

around one-quarter of transfers each. The remaining 25 percent of transfers includes

various historically smaller assistance programs such as unemployment insurance,

veterans’ benefits, and food assistance. California personal income is then projected to

grow at 4.6 percent in 2023 and at 4.7 percent 2024, around the same pace as in 2019.



Construction and housing activity remained fairly resilient in California despite

California’s historically high cost of housing due to the strength of the purchasing power

of high-income households. California median home sales price of existing single-family

homes exceeded $700,000 for the first time in August 2020 and continued to increase to

a record-high of $758,990 in March 2021, 30.9 percent above the February 2020 level.

With strong continued demand for housing in California, the number of housing units

authorized by permits remained above 100,000 units in 2020, at around 105,000 units.

Authorized housing units decreased by 4.7 percent in 2020, a smaller decline than the

drop of 4.9 percent in 2019, as long-term issues of permitting and housing supply

constraints predate the recession. Permitted housing units are projected to increase by

10.2 percent to 116,000 units in 2021 and to reach 135,000 units by 2024.

Higher housing costs and housing constraints in the state continue to drive California

inflation to remain higher than the nation in the long-run. After a deceleration from

3 percent in 2019 to 1.7 percent in 2020, California headline inflation is projected to

accelerate to 2.5 percent in 2021, on par with the nation, but from a higher base.

Beginning in 2022, headline inflation in California is expected to grow slightly faster than

the nation in line with historic trends. Overall California inflation is then projected to slow



to 2.2 percent in 2022 before gradually increasing to 3 percent by 2024, in line with the

pre-pandemic pace in 2019.

RISKS TO THE OUTLOOK

Despite significant improvements over the past year, there is a long road to full recovery

and risks to the outlook remain. Immediate risks include public health concerns with

new virus strains and vaccine hesitancy, higher inflation if disrupted supply chains

cannot support increased consumer demand, more frequent and more widespread

wildfires, and a stock market correction that would impact higher-income Californians

and state revenues.

High-income workers have been largely insulated during the recession, limiting the

negative impacts of the public health and economic crisis on California’s personal

income and revenues. However, public health challenges and complications could

lead to reinstated public health restrictions and a loss of business and consumer

confidence that could affect the stock market, resulting in a more generalized

recession that impacts all sectors. Individuals and businesses could experience a more

difficult transition to the new post-COVID-19 normal than anticipated, leading to a

slower recovery or even to a new downturn. If more businesses enter bankruptcy due to

weak economic activity high-income workers may also lose employment.

To illustrate these economic risks, the Department of Finance has developed a Stress

Test scenario. This scenario would more closely resemble the unfolding of the Great

Recession, which also began in a few sectors of the economy before becoming

widespread. Under the Stress Test scenario, California would lose jobs in both low- and

high-wage sectors starting in the third quarter of 2021 and through the first quarter of

2022, undoing economic growth since the second half of 2020. California nonfarm

employment would recover to pre-pandemic levels three years later than in the

baseline scenario, reaching pre-pandemic levels in 2026 rather than in 2023. The overall

nonfarm employment recovery would then take about the same time as during the

Great Recession. (See previous figure on California Job Losses and Years to Recovery.)

The stock market has continued to benefit from federal policy to cushion the financial

sector, and the large increase in private savings in 2020 also likely led to more

investment in stocks. The shift towards telework has supported information and

technology companies which also tend to be among the top S&P 500 companies,

many of which are headquartered in California. However, risks of a second and

potentially worse stock market downturn remain, and would happen from a much



higher base given recent record-highs. Given California’s reliance on capital gains, a

stock market correction would significantly and adversely impact the state’s revenues.

Climate change and more frequent extreme weather events continue to be a risk to

California. The year 2020 was California’s most widespread wildfire year on record and

2021 is on pace to become one of the driest years on record. The ongoing risk of

worsening wildfire seasons will likely affect individuals' and businesses' livelihoods and

decisions on where to reside and conduct business, which may impact the growth of

regions that are most at risk, as well as cities and towns which are regularly impacted by

smoke and pollution. Rising sea levels may also introduce new challenges to some

coastal communities in the future. Other environmental risks such as the ongoing threat

of droughts remain, with 41 counties in California having a drought-related state of

emergency in place as of May 2021.

Finally, other longer-term structural risks that predated the recession remain, and some

of these risks have been exacerbated by the pandemic. These risks include California’s

housing shortage, which continues to put pressure on inflation and prices, limiting

Californians' ability to afford a home. Other risks include increased inequality as many

households are struggling to provide for essentials, slowing population growth as

migration flows and fertility rates decline, and the challenges of an aging population.



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